AO World pressure heralds a different kind of retail crisis

AO World borrowed the catchy “Hey ho, let’s go!” introduction from the Ramones’ hit “Blitzkrieg Bop” for its advertising tagline. But right now investors might be thinking more of another hit from the New York punk rockers’ oeuvre: “I Wanna Be Sedated”.

On Wednesday the online electricals retailer said it would raise £40mn via an equity issue. It described the move as “a sensible piece of housekeeping” barely 48 hours after reassuring the market that the partial withdrawal of trade credit insurance would not impact its liquidity.

The placing, which the company said was in the works before press reports about credit insurance surfaced, came at a 9 per cent discount to a share price that had already shed almost four-fifths over the past year, including 30 per cent in the two preceding days. It is obviously dilutive, expanding the existing share capital by nearly a fifth.

But it is only the second post-IPO fundraising AO has undertaken and it is better than the alternatives — which include being taken private at a derisory price or staggering into peak sales season with constrained working capital.

The announcement was accompanied by a notable strategic pivot. After an expensive misadventure in Germany, and the Netherlands before that, the company has dialled down the European land grab in favour of a focus on profitability in its core UK market.

For the first time in its existence AO has publicly set financial targets — annual sales growth of 10 per cent at a cash profit margin of 5 per cent — though not committed to a timeframe for hitting them.

It all looks like a repudiation of the usual online modus operandi, which entails all profit and cash flow being reinvested in warehouses and delivery capability and customer recruitment in the expectation of profits at some future date.

When money was cheap and underlying markets were growing that model looked like it might work. It certainly appeared so during the pandemic, as savings piled up and consumers were kept out of shops by multiple lockdowns.

But as traditional retailers get the hang of ecommerce, debt ceases to be virtually free and the spectre of recession haunts consumers, it is running into trouble.

Share prices tell the story, whether in fashion (Asos and Boohoo are down four-fifths in a year), in DIY (Victorian Plumbing, down by the same) or home furnishings (Made.com, off a mere 77 per cent).

So instead AO is now prioritising margin — 5 per cent is almost double the highest level it has ever achieved as a public company, according to CapitalIQ data. And relegating sales growth, which would be half the annual average over the past seven years.

It may be a while before investors can pass judgment on the new plan for slower growth but improved profitability. With its balance sheet patched up, AO’s most immediate problem now is demand. The peak trading period for electricals, from Black Friday to Christmas, is likely to be when cost of living pressures start to be felt most acutely.

A lot of what AO sells is big-ticket and discretionary, as HSBC analysts pointed out this week when they lopped a quarter off their 2023 profit forecast for the UK’s market leader in electrical retailing, Currys.

Still, AO’s group ebitda margin has historically been depressed by its lossmaking overseas ventures. In the UK, it has a market share of around 20 per cent in white goods and does make operating profits. It is unlikely to go bust.

But restructuring types expect the next crop of retail failures to include online-only operators as well as over-spaced and overleveraged high street names, pointing to the collapse of Missguided earlier this year.

That will bring its own challenges. Online retailers tend to have fewer tangible assets. Realising their inventory requires the co-operation of various third parties, most obviously whatever entity owns the warehouse in which all their stock is housed. Landlords of individual stores wield a lot less power by comparison.

It may also finally bury the idea that ecommerce is somehow easier or inherently more profitable than the traditional variety. “Halfway to Sanity”, as the Ramones might have put it.